Shorted Stocks Finally Catch a Break

While much of the attention in recent weeks has been on the change of fortune among high-flying momentum stocks, there’s also been a big rally among many of the stocks with the largest number of bearish bets.

That’s not a coincidence, traders say.

Rallies in the some of the most heavily shorted stocks are being driven by hedge funds broadly pulling back on all their stock positions–bets that individual stocks would both rise or fall. So as hedge funds have ditched bullish positions in high-growth stocks—many of which have gone sour—they have been simultaneously closing out short positions as well.

The percentage of shares out on loan to short sellers has been dropping for several days, data from Markit show. On March 25, the average percentage of shares in S&P 500 companies on loan was about 2.25%. By last Friday, it was down to 2.14%, the lowest percentage since Feb.4.

“The market overall has held up very, very well, but that is despite the fact that you’ve had, below the surface, a very large de-risking which has been concentrated in the hedge fund community,” said Joe Spinelli, head of cash equities trading for the Americas at Deutsche Bank.

Among the top 10 most shorted stocks, seven of the 10 rallied over the last month, a period when the S&P 500 is down 0.8%.

Four of those names–United States Steel Corp., Frontier Communications Corp., Quest Diagnostics Inc.,and Gamestop Corp.–are up by double-digit percentages.

The rise in heavily shorted stocks coincides with a major pullback by many high-flying biotechnology, social media and information technology stocks in recent weeks. The stocks were heavily favored by hedge funds, but many—including Netflix Inc., Facebook Inc. and Tesla Motors Inc.—have posted double-digit declines over the last month.

Hedge funds broadly have had a difficult month as popular bets on high-growth stocks have gone south. The last week of March was one of the worst weeks for stock hedge-funds’ returns compared with the S&P 500 since 2001, according to Goldman Sachs.

Below are the top 10 most shorted stocks in the S&P 500 as of April 7, as measured by the percentage of total shares out on loan, and a report on their performance over the past month.